ARTICLES

Federal Estate Tax To Expire in 2010

By Benjamin T. Branche

Tax, Trusts & Estates Section

The Federal Estate Tax is set to expire in January 2010. Over the last eight years, this tax has been phasing out, with exemption amounts increasing and tax rates decreasing each year. This phase out of the Federal Estate Tax was part of the 2001 Economic Growth and Tax Relief Reconciliation Act ("The 2001 Act").

While the Federal Estate Tax will be entirely repealed for individuals dying after 2009, the repeal of the Estate Tax will sunset after 2010. At that time, the tax rates and exemption amounts will revert to the 2001 amounts unless Congress takes action to continue the repeal. If Congress does not pass legislation to continue the repeal, the estate tax will be repealed only for those who die in 2010. Unlike the estate tax, the gift tax is not being repealed during 2010. It will remain in effect, with a top gift tax rate of 35%. Under the sunset rule, the top estate and gift tax rate would revert to 55% in 2011.The estate and gift taxes would be re-unified in 2011, with the exemption returning to $1million for both estate and gift tax purposes.

Proposed Legislation

Numerous bills have been introduced in the House to address the estate tax exemption before it sunsets. Based on the political and economic climate, it is likely that the estate tax exemption will be frozen at $3.5 million for a couple of years and the rate will remain at 45%. Hopefully, a longer-term solution will be approved; however, it currently looks like a short-term patch will be applied until a long-term resolution can be reached. The option of portability of the exemption between spouses has also been proposed. This means that when one spouse dies and all assets pass to the surviving spouse, the surviving spouse may have an exemption of $7 million. The passage of the portability of the exemption is not likely to occur immediately; however, the lock-in of the rate will likely occur. Further, the gift tax will be re-unified with the estate tax and the step-up in basis will continue. Additional changes that may come into play are the elimination of short term Grantor Retained Annuity Trusts and no discounts for intra-family transfers of family entities.

Uncertain Impact on Planning

The uncertainty of whether the sunset provision will ever come into play and whether an individual will die during a period of increasing exemption amount make planning difficult. Because of the way the law works, when income tax costs are factored in some heirs would actually face higher tax costs if their benefactor dies in 2010, when the estate tax is scheduled to be repealed, than they would if he or she had died before 2010.

What To Do

Individuals should continue to write wills and develop estate plans to ensure that their assets will pass as they desire and that special needs of particular heirs will be properly addressed. This is so even if there is a good chance of survival until a year when estate tax won't be owed because of the increasing exemption or repeal.

Individuals who may have an estate larger than the $3.5 million exemption amount that applies in 2009-or the $1 million amount that is currently scheduled to apply for 2011 (when the estate tax is scheduled to be restored one year after it is repealed)-should make annual exclusion gifts each year. The gift tax annual exclusion allows you to give $13,000 to an unlimited number of donees each year without paying gift tax. By doing this, you remove the gift amounts from your estate and save estate tax. In addition, you remove the post-transfer growth in the gifts from your estate.

Other steps to reduce estate tax include setting up a life insurance trust, establishing a grantor retained annuity trust (GRAT), and placing one's residence in a special type of trust called a qualified personal residence trust (QPRT).

Special Factors for Married Couples

Married couples should make sure that each spouse has sufficient assets in his or her own name to take advantage of the increased exemption. In addition, their wills should establish a so-called bypass or credit-shelter trust. This trust is funded with an amount equal to the exemption from estate tax. The survivor gets income from the trust and the assets in the trust pass to the children free of estate tax on the survivor's death. Assets above the exempt amount can be given outright to the surviving spouse or placed in a special marital trust for him or her. This approach may have to be altered depending on the year involved and the size of the estates.
Record Retention

With the scheduled change to a modified carryover basis system in 2010, it is essential that you retain all records of cost or other basis.

• For purchased items, this means receipts and statements showing the amount you paid for it.
• For items inherited before 2010, basis ordinarily is the date-of-death value of the item.
• For property acquired by gift, the donee's basis usually is the same as the donor's.
• For depreciable property, basis is reduced to reflect allowable depreciation.

The New Jersey Exemption

Originally, states were "coupled" with the Federal Estate Tax under the 2001 Act, which meant that the tax due to the state was equal to a credit for taxes paid to the state under the 2001 Act. This state death tax credit was eliminated in 2001; therefore, eliminating the tax paid to states. However, some states "de-coupled" and implemented their own estate tax rules. New Jersey is one such state. New Jersey estate tax is now imposed upon the transfer of the estate of every resident decedent which would have been subject to a Federal estate tax under the provisions of the Internal Revenue Code in effect on December 31, 2001. Put simply, New Jersey taxes any estate which exceeds $675,000.

Review Your Will and Your Estate Plan

Given the proposed changes in the estate and gift tax laws, it is important to have your estate plan reviewed. Although the uncertainty of changes to the estate tax law presents planning challenges, an estate-planning professional can help you keep your heirs' estate and income taxes to a minimum. For more information, or to schedule an appointment to discuss your estate plan, contact Ben Branche of our Tax, Trusts & Estates Section.